Streetwise Professor

January 20, 2010

Strange Bedfellows

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 9:57 pm

I sometimes disagree with Economics of Contempt, but he wrote a post yesterday that pretty much repeats my points that the fact that end users freely choose to trade on dealer markets despite the assiduous attempts of exchanges to woo them means that OTC trading must dominate exchange trading for a large group of firms:

More broadly, notice who the intended beneficiaries of all Mike’s preferred requirements are: not average taxpayers, mind you, but the end-users who trade OTC derivatives. These end-users are predominantly large institutions — bond managers, institutional investors, hedge funds, large corporates, etc. If pre-trade price transparency would be so beneficial to them, then why haven’t they already moved to exchanges? There’s absolutely nothing stopping them — the exchanges have been offering OTC lookalikes for years, with little success. The problem is that no one wants their products. And it’s not like there’s no competition in this space. To the contrary, the competition among the different trade execution venues (ECNs, dark pools, etc.) is incredibly fierce.

Even the price competition in the traditional OTC market is fierce, despite what journalists think. For example, according to Risk‘s 2009 survey of corporate end-users, 65.3% of end-users listed price as the most important factor in choosing a derivatives dealer. Fully 73.5% of end-users negotiated with 2-3 derivatives dealers before agreeing on a trade, and an additional 14.3% of end-users negotiated with 4-5 dealers.

I recommend reading the whole thing.

I don’t necessarily agree with EOC’s advocacy of requiring all trading in “standardized” derivatives go through clearinghouses.  Beyond all of the nettlesome issues relating to just what “standardized” is (and contractual standardization is clearly not a sufficient condition to make clearing practical), all of EOC’s arguments stated in this particular post can be achieved through mandatory reporting, which is different from clearing.  Clearing involves a mutualization of default risk; the informational advantages that EOC touts can be achieved without such (problematic) mutualization.

And one personal quibble.  (I know.  It’s always about me.)  EOC’s post responds to a Mike Konczal piece which is a direct response to something I wrote for FTAlphaville.  EOC:  Would it kill you to (a) acknowledge that, and (b) give some props for the fact that I made several of the arguments you advance in this post . . . before you did?  Just asking.

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  1. “EOC: Would it kill you to (a) acknowledge that, and (b) give some props for the fact that I made several of the arguments you advance in this post . . . before you did? Just asking.”

    — difference between blog writers and refereed journals? 😀

    Comment by Surya — January 21, 2010 @ 3:11 am

  2. I dunno, S. I try to give credit where it’s due, both in citations in papers and in the blog. And believe me, there are some putzy academics who don’t cite properly either.

    The ProfessorComment by The Professor — January 22, 2010 @ 4:27 pm

  3. Sorry for not mentioning your post. I got most of my post from an email exchange I had with Mike Konczal a while back, so I wasn’t really looking at his post when I was writing. I’ll update my post when I get back to NY.

    Comment by Economics of Contempt — January 22, 2010 @ 6:58 pm

  4. Thanks, EOC. Sorry for being a little peevish. We should talk clearing some time.

    The ProfessorComment by The Professor — January 22, 2010 @ 8:32 pm

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